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The basis of the Discount Rate: all views needed

Responding to the consultation on changing the Discount Rate is not just for financial experts.

The basis on which the Discount Rate is calculated, as well as the actual rate, is of critical importance to claimant and defendants alike and the government needs to understand the impact of any decision it makes from both sides.

Traditionally defendants have been less active than claimants when it comes to responding to consultations, but it is imperative that the government sees how seriously compensators are taking the Discount Rate consultation.

With the government consultation on whether to change the current rate of 2.5 per cent closing on 23 October, it is vital that the Ministry of Justice is aware of the strength of feeling among compensators that it should change the basis on which the rate is calculated.

Having taken soundings from interested parties (including public bodies, composite insurers and those who self insure), I suspect that the general consensus could be that the ambit of this initial consultation (with its detailed review of the financial returns on investment) is one for accountants and financial experts to answer. However, the general principles of investment management and what happens in real terms are as important and need to be highlighted to the Ministry of Justice.

The current basis for calculating the Discount Rate is index-linked government gilts (ILGS), on the basis that they provide secure investment protected against inflation. However, the low return from ILGS in recent times has prompted calls from claimants to cut the Discount Rate and thus increase the damages they receive. However, this assumption fails to recognise the reality that claimants do not invest their damages in such stock. Instead they typically put their money into a mixed portfolio of investments (which is the other option canvassed in the consultation).

There is good evidence that claimants have been able to achieve real rates of return, net of tax, of up to and above 2.5 per cent. Therefore adopting a Discount Rate lower than 2.5 per cent risks over compensating some claimants.

In short, it would be unfortunate if the government took the view that investing in government gilts is the panacea of investment models. There are so many variables at play that there would be real dangers in adopting a "one size fits all" approach. It is vital the government looks at what claimants really do with their money now before making a decision to change the Discount Rate.